The management fee is 1.3%. This is the only part of the expense ratio that goes to Militia Investments. The rest is in a category called “Dividend Expense, Borrowing Costs and Brokerage Expenses on Short Sales”, which you can see in the prospectus. The biggest component is the dividend expense from shorting. When a fund shorts an asset, it pays the distributions that asset makes. However, the asset falls almost the same amount as the distribution, making the economics neutral.
Part of ORR’s strategy is shorting high distribution yield ETFs, which leads to inflated dividend expenses. ORR also pays interest to obtain leverage. This is a real economic cost to the extent that ORR pays interest above the risk-free rate. It also pays borrow costs on shorts, but ORR tends to favor shorting assets with low borrow costs.
Because ORR is new, these costs were estimated based on Militia’s initial holdings. We were aware from the start that our strategy of shorting high-yield assets would cause a inflated and, in our opinion, misleading expense ratio that would make the fund harder to market. But we’re pursuing this strategy anyway because our goal is to produce the best after-tax, after-fee risk-adjusted returns for our investors, regardless of the accounting optics.
Most of the time, it is best to use limit orders because limit orders allow you to direct the purchase or sale of the ETF at a specified price or better. If you’re not in a rush, you can place your limit orders within the bid-ask spread.
Based on the legal structure of ETFs and the current strategy, it’s unlikely that $ORR will have to make taxable distributions.
ORR trades on US hours but a large percentage of ORR’s holdings are foreign stocks that do not trade during US hours. The foreign stocks are priced at the close of their trading day. This timing mismatch creates differences between what market makers are willing to quote the ETF at and the official NAV of the ETF.
Some of the premium and discounts are due to the less liquid foreign stocks ORR owns. This makes it costlier for market makers to hedge. Note that volatile days are likely to have a bigger impact on premium and discount pricing.
ORR is also a newer fund, so it doesn’t have as much trading volume, which can also impact the bid/ask spread
While there has historically been a lot of overlap, the ETF is a distinct strategy due to differences in liquidity constraints, taxation and transparency of the ETF vehicle.The in-kind creation/redemption feature of the ETF structure allows us to sell appreciated stocks without having to distribute capital gains. The hedge fund does not have this privilege so it may keep positions that it would have otherwise sold due to tax implications.The ETF owns more liquid stocks than the hedge fund for several reasons:
1) An ETF can experience large daily inflows or outflows that are out of our control.
2) The ETF is largely obligated to trade positions at the end of the day, meaning we must be mindful of ownership in less liquid stocks to minimize price impact when entering or exiting a position.
3) Owning too many less liquid or thinly traded stocks in the ETF would widen bid-ask spreads for investors. Laws and regulations also determine liquidity constraints in the portfolio.
The biggest differences between the strategies are in the short book. Currently, $ORR does not short many individual stocks. This may change as the ETF’s assets grow. However, microcap shorts, crowded shorts and companies that have significant short risk squeeze do not fit in an ETF for many reasons related to the mechanics of shorting. Besides that, if an entire short book is revealed and many of them are risky it may have negative implications for the ETF because $ORR’s holdings are public.
$ORR also generally has a higher beta to the stock market (0.5+).
For the most part, no. ETFs, unlike traditional mutual funds, gain and lose assets via in-kind creations and redemptions performed by market makers known as “authorized participants”, or APs. The APs are responsible for acquiring and disposing shares of the underlying assets. This means ORR does not have to buy and sell shares of the underlying assets to meet creations or redemptions.
However, transaction costs are indirectly borne by the investors who are buying and selling the ETF. If there’s a lot of buying on a particular day, the market makers will demand a premium to hedge their exposure to the underlying assets, some of which are hard to hedge against. If there are lots of outflows, the market makers will likely price shares at a discount. Current holders are largely unaffected except to the extent that buying/selling pressure from ORR causes the underlying asset prices to change.